Chapter 9 - The Financial Markets

Question 1

What are the two models to determine prices in the stock market?

Answer 1

Call auctioning (fixing):

• Orders a collected for a time period, then they are matched to determine the price which will maximize the number of traded shares
• Your price information is not given to the market - more suited for low volumes of transactions

Continuous trading:

• Posting permanently the best purchase price and the best sale price. The interested counterparties come and agree or not tot trade at the quoted prices.
• Good for stocks traded at high volume (all the big stocks)

Question 2

How is the price determined through call auctioning (fixing)?

Answer 2

Number of orders has to be accumulated on both the sell and buy size

When selling: the sellers willing to sell for price X (the lowest) and above has to be accumulated (the higher the price, the larger the quantity).

When buying: the buyers willing to sell for price Y (the highest price) and under has to be accumulated (the lower the price, the more buyers)

The price on which the most orders have been placed will be picked

Seeking to maximise the number of transaction, so the lowest difference between buy orders and sell orders.

Question 3

What is the bid-ask spread? And what does the value of the spread depend on?

Answer 3

Bid-ask spread: difference between the highest buy order, and the lowest sell order.

Very liquid stocks have small spreads.

• The more uncertain (volatility, risk) the stock price, the higher the bid-ask spread
• Bid-ask spread is larger at the opening and close of the market

Question 4

How do you calculate the preferential subscription rights (PSR)?

Answer 4

PSR=P−(n∗P+n^′∗P′)/(n+n′)

Question 5

How do you calculate the MarketCap?

Answer 5

MarketCap = number of shares * price of shares

Question 6

What is the PE ratio?

Answer 6

Price Earning ratio

PE = P/EPS = MarketCap/Net income

EPS = Earning per share

Represent number of years to pay off the price of share using profit (assuming constant profit)

High per –> investors willing to pay more, anticipate growth

Question 7

What is the market-to-book ratio?

Answer 7

The markets expectation of value creation by the firm

MTB = market value/book value = MarketCap/Equity value

Equity value = total assets - total debt